Investing Rules – How to Invest in Stocks

Investment is defined as putting aside certain sum of money with the expectation of gain in future. We invest our money in various financial products like gold, real estate, bonds, stocks with the aim of getting better returns over this money instead of keeping it idle in savings account.

Before Investing we should Ideally

• Assess income and expenditure

Before investing we all should be aware of the total monthly income and total expenditure so that an estimated amount can be calculated. This amount can give an idea about the excess amount or the amount which can be saved.

•  Make Financial goals

It is advisable to jot down the financial goals on a piece of paper so that money can be invested accordingly basis the time horizon.

•  Know Oneself

It is essential to analyze one`s own risk taking capability and financial personality basis which amount can be invested in high risk or a low risk instrument

In this article we shall discuss regarding rules of investing  and stock market basics some of which may be specific to stock market trading whereas other may apply to all investment products.

1. Diversify

There is a common Saying:- “ don’t put all eggs in one nest.”

This rule works with all investment products. Nobody can predict the future as there could be a sudden economic, political or any other change which may lead to huge losses if investment is done in similar products. Thus investing only in equities or investing solely in debt is not advisable.  In case of a mixed portfolio the impact of loss would not be enormous.

Example:-Mr. Ahuja had purchased shares of Satyam Computer services for a total value of Rs.50000 in November 2007 as he received a bonus from his company. He had invested the entire amount in 1 particular company. Everything was working fine in Mr. Ahuja`s portfolio till 2009 but suddenly things began to change as the scam came in place. After the scam, entire portfolio was in red due to excessive purchase of one particular stock.

CBI has confirmed that total loss to investors due to this scam is Rs.14, 162 Crore.

2. Make a Thorough Research

This rule also applies to all investment categories. Before investing one should make a detailed research about the quality of the companies selected. Quality signifies strong management team and a proven track record.

 3. Not To Panic

It applies particularly to stock market investing. It usually happens that in case of crash of a stock market, people get panic and they sell off their holdings the very next day. But instead of selling at the first stage itself one should review his portfolio and then decide if the stock has lost its attractiveness and if more attractive stocks are available in market.

4. Expect Corrections to Happen

It`s been observed that many investors believe in only one sided direction of markets like in case of downturn people loose faith in equity products and stop investing in these products. But in reality markets tend to return to the mean over time which means market extremes never lasts forever be it optimism or pessimism.

Also when there are no more buyers, the market turns lower and vice versa.

5. Know Your Risk Tolerance

As highlighted previously also it is very essential that the investors analyze their risk tolerance level and accordingly select the investment products as some of the products/ stocks are more risky than others. One should figure how much downside one can tolerate without selling

6. Portfolio Monitoring

It becomes very essential to keep a track on the portfolio regularly as nothing is permanent. High return generating products may lead to huge losses for the investors after some years if the company is going through a bad time.

Example:-the shares of Kingfisher Airlines which were attractive once upon a time no longer attract the investors due to crisis within the company.

7. Don’t Follow Others Blindly

When the prices are high a lot of people are actively buying the stocks. When price is low demand is also low as the people are pessimistic and also discouraged. Thus the entire market collapses. We should adopt an independent thinking instead of blindly following what other are following.

Benjamin Graham says” Buy when people are pessimistic and sell when they are optimistic.”

8. Avoid Fear and Greed

Greed and fear are human emotions which create obstacles in the path of successful investing. One should follow a disciplined approach to trading and should be able to figure out time to exit. There will be corrections as stocks go up and down.

9. Remain Flexible and Open Minded

There is no particular investment which remains best throughout. Depending on the situation one needs to switch to different investment avenues. If a planner suggests to shift the amount to bonds or other debt products looking at the volatility one should be flexible enough to support the advisor

10. Invest For Max Real Return

One should take into account the real return after taking into consideration the impact of taxes and inflation.

Real Rate of Return= {(1+ rate of interest)/(1+inflation rate)-1} *100

Example:-if inflation is 6% and rate of return is 10%, the real rate of return equals:-

{(1.10/1.06)-1}*100=3.77%

11. Learn From Your Mistakes

We should not be discouraged from the losses rather earlier mistakes should be taken as a learning experience. We should analyze and check what went wrong previously so that same mistake can be rectified in future.

12. Don’t Buy Market Trends

We should not base our decision on what`s happening now.  The individual stocks can rise in a bear market and fall in bull market. Thus we should study all the factors before taking any decision.

Conclusion

Investors should carefully read all offer documents and do a detailed study about the various products available in the market and should know stock market basics before investing. These rules would also be helpful in making a right investment choice.